Quantitative easing a last resort
As expected, the Bank of England left the Bank Rate unchanged at 0.5 percent at the April meeting, the first unchanged decision since September 2008.
The accompanying statement was short and sweet. The Bank has accumulated 26 billion pounds of asset purchases and will take a further two months to complete the planned 75 billion pounds of purchases – see you next month!
It is disappointing that gilt yields haven’t remained low – partly because of firmer economic data, but also because the market is wary of the exit strategy. Hence the statement was a bit of a missed opportunity. The Bank has run out of interest rate ammunition and hence is having to use alternative measures including quantitative easing. Some form of verbal intervention, voicing a desire to get gilt yields lower could have been a cheap and easy way to loosen conditions in the economy.
Ultimately we expect the scale and duration of quantitative easing to be more than most expect. Our models suggest that if the Bank Rate could fall below zero, interest rates “should” be -4 percent. That shows the magnitude of the stimulus that is required from unconventional policy. Given this, we expect Bank purchases of assets to amount to as much as double the 150 billion pound that the Bank is currently authorised to spend.
Quantitative easing is called unconventional policy for a reason. It is the last resort. We don’t know if it will work; if it does work we don’t know how well it will work or how quickly it will work; we don’t know how big any side effects will be. If it was so fast and effective then it wouldn’t be unconventional – we wouldn’t bother moving the Bank Rate, we would use QE instead.
The point is, it is going to take a long while before we discover if QE has worked. The typical lead time between interest rates and the economy is 12 to 18 months. Hence as a starting point, that is the horizon over which we should be able to conclude whether the programme of asset purchases has worked.
The definition of whether it is working is a little blurred. The lion’s share of the fall in gilt yields since QE began has since been reversed. Hence if one objective was to lower market interest rates, it is hard to conclude that the programme has been a success. The situation was not helped by comments from Bank Governor Mervyn King that frightened the market into positioning for the exit strategy barely five minutes into the QE programme.
One area that the Bank will be encouraged by is the compression in non-financial corporate bond spreads relative to the eurozone (where asset purchases have not begun). This, and the narrowing in the liquidity premium are potentially helpful in facilitating easier financing conditions for companies. Judging whether the availability of credit more widely to firms or households has improved since QE started will take much longer.